How Much Car Can I Afford?

How much you should spend on a car depends on a range of factors, and it's important to take all of the costs of owning a car into consideration before buying.

For most of us, a car is a necessity—not a luxury. Without one, getting to work, schlepping groceries, and all the other trips of adulthood become difficult, if not impossible.

But figuring out which vehicle to purchase—and how much you can afford to spend on it—isn't easy.

“A car is the second biggest purchase most of us ever make, and it’s not something that needs to be done quickly,” says Sonia Steinway, co-founder of Outside Financial.

Not sure where to start with your budgeting?

We spoke to experts who shared tips and guidelines to help you determine exactly how much car you can afford to purchase—and why it's a good idea to keep your transportation costs low.

Let Income Guide Your Car Purchase

Your gross income (that is, your before-taxes earnings) is the first, best tool to determine what you can afford.

Dakota Brizendine, partner at Commonwealth Financial Group in Burlington, VT, shares a simple rule of thumb: If you make $100,000 or less, your car payment, interest, and insurance should not exceed 8 to 10 percent of your income.

Say your income is $50,000 a year. That would put monthly car expenses (not including gas) at $417 a month—or lower.

With a higher income, her recommended percentage for car costs dips even further. “If you’re making over $100,000, we generally want to see transportation come in at 5 to 7 percent of your income,” says Brizendine.

Too much math? Search online for car affordability calculator to help you see the breakdown.

Set your budget before you start shopping for a new car—and stick to it!

Determine What You Can Borrow

If you’re not buying a car with cash, you’ll need to take out a loan.

“It’s really easy (and smart) to get pre-qualified for a loan before going to the dealership,” says Steinway. That’s because many dealers markup loans, says Steinway—to an estimated average of more than $1,700.

You can get a loan through many financial institutions, but if you belong to a credit union, or can join one, take a look at their rates.

“I’m a big advocate of using a local credit union if you have one—often they can offer very competitive rates,” says Brizendine. These rates, she adds, may be better than what you’d get through your dealer or a major bank that you don’t have a history with.

Whether your financing is through a bank, dealership, credit union, or any other financial institution, lenders take several factors into consideration when creating the terms of the loan, says Steinway. These three C’s are:

Credit score: Having a healthy credit score will help you get a better rate when you borrow money, says Brizendine.

Collateral: Steinway defines this as the car's value. Lenders use it to calculate the loan-to-value ratio—the size of the loan divided by the appraised value of the purchase—to help determine the risk of the loan.

Capacity to pay: Reasonably enough, lenders want to feel confident you won't default. To assess, they’ll use your debt-to-income ratio and payment-to-income ratio, says Steinway, to evaluate how much income you have available to pay off the loan.

All lenders weigh these three factors slightly differently—that’s why not all loan offers are the same. And if you’re financing the purchase of a used car, take note: “Rates for used cars are typically slightly higher than for new cars,” says Steinway.

Put Money Down If You Can

You can still get a car if you don't have the cash on hand for a down payment (just think of all those car commercials trumpeting "zero down"). But the more you put down, the less you’ll have to borrow (and pay interest on). And, notes Steinway, making a down payment “shows lenders you're serious about paying back your car loan, so it can increase the likelihood of getting good loan offers.”

Photo credit

Photo: TierneyMJ / Shutterstock

Photo caption

Look to the future when buying a car and add in unexpected expenses to your calculations.

Don't Forget to Factor in the Unexpected

Along with your monthly car payment, you can expect several other expenses as a car owner: insurance, tolls, fueling up at the pump, and routine maintenance are the biggies.

And then there are more unexpected bills—you may, for instance, get a speeding ticket or a flat tire. An accident can mean expensive repairs. Big things can break, which again will require repairs.

Budget for these expenses, keeping in mind that both repair and upkeep costs can vary from one vehicle to another, says Steinway. To get a sense of the variation, she says, use an online total cost of ownership calculator (such as this one from Edmunds).

Key Takeaways

Once you nail down the amount you can pay, the fun part comes next: picking a car.

"Once you’ve decided on a few makes or models you’re interested in, we recommend contacting at least three dealers to ask for their best drive-away price," says Steinway. You should request a buyer's order for new cars and a book-out sheet for used cars. "This will allow you to compare apples to apples and force dealers to compete against each other," she says.

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